The taxman cometh

After a rush to close deals in 2012, the fiscal cliff deal could now chill sales
By Tom Acitelli | February 01, 2013 07:00AM

Anyone who’s picked up a newspaper or logged onto the Internet in the last month knows that lawmakers cut a last-minute deal to avoid the so-called fiscal cliff, narrowly avoiding widespread tax increases and deep spending cuts. But now New York real estate investors and home buyers — along with their accountants — are watching closely to see how that deal will affect the residential and commercial markets here.

The major impact for New York real estate, observers said, could come from increases in federal capital gains rates, as well as from a Medicare surcharge tied to President Barack Obama’s Affordable Care Act. Some speculate that the capital gains increases (which range from 5 percent to 8.8 percent on the margin) could cause a drop-off in the number of properties traded, as well as an increase in asking prices for residential and commercial real estate.

While experts said they don’t expect to see a “property cliff” to follow the fiscal one, industry insiders forecast something of a chill. (See related story, “‘Cliff’ deal’s housing bonus.”)

“If you’re a seller, you look at what you’re getting for the transaction, you look at what taxes you have to pay and you look at what’s left,” said Francis Greenburger, chairman and CEO of Time Equities, which owns 20 million square feet of property worldwide. “To the extent that the [tax] burden on me as a seller is greater … I’m less motivated to sell.”


Sales slowdown

In the past, federal tax changes have significantly impacted the real estate market.

Changes in 1986, for example, did away with major tax shelters for real estate investors, including the deduction from their gross incomes of losses from property investments. As a result, property values plummeted as investors fled the real estate market. The stock market nosedived, too, the following year.

So far, at least, “that hasn’t happened” this time around, said Mitch Roschelle, head of the U.S. real estate advisory practice at PricewaterhouseCoopers.

Observers noted, however, that the real estate market could see some impact from the fiscal cliff deal, which stipulated that capital gains tax rates will rise from 15 to 20 percent for individuals making more than $400,000 in adjusted gross income, or AGI. For married couples, the threshold is $450,000. Investment income, including capital gains through real estate trades, is now subject to a 3.8 percent Medicare surcharge, depending on various modified AGI thresholds, including $250,000 for married couples filing jointly.

These changes could translate into fewer properties changing hands in 2013, industry experts said.

In fact, as The Real Deal and others have reported, there was a rush among homeowners to unload property before the end of 2012 in anticipation of tax changes. According to data from Miller Samuel Real Estate Appraisers, Manhattan apartment sales spiked 29.2 percent year-over-year in the fourth quarter, traditionally the slowest time of the year for sales.

Manhattan sellers who did not unload their properties last year may now try to make up the difference through higher asking prices. “Are sellers going to try to recover? Of course they are,” said Jennifer Johnsen, executive sales director at brokerage MNS.

Or in the words of Joel Rosenfeld, who teaches real estate finance and taxation at New York University’s Schack Institute of Real Estate: “You raise corporate taxes and the next you thing you know, you’re paying more for toothpaste.”

Many investors, from individual homeowners to large-scale landlords, also moved property through gifts or transfers to trusts as 2012 wound down.

“I had a lot of clients doing — or contemplating doing — significant gifts because they didn’t know what was going to happen, and they didn’t find out until January,” said Kenneth Weissenberg, a tax attorney and head of real estate client services at the accounting firm EisnerAmper.

For those who didn’t make tax-related changes in 2012, accountants are now advising them to move profits from commercial real estate sales into other properties via a 1031 exchange. That allows sellers to defer taxes if they invest the profits from one real estate trade into another property within six months of the closing.

“I will say the majority of those sellers will continue to use the like-kind exchange rules to defer their taxes,” said Shahab Moreh, head of real estate services at accounting firm WeiserMazars.


Too small for change

In other areas of real estate, however, tax changes may have little impact.

Like other dividend-producing stocks, earnings on real estate investment trusts, or REITs, are subject to the higher capital-gains rates, so some investors might pull back to avoid the higher rates. But analysts said the single-digit-percentage increases will likely not dissuade many from investing in REITs (see related story: IPOs on the horizon).

“I think the question becomes, what other alternatives do individual investors have?” said Roschelle. “If they want to invest in a dividend-gaining stock and they decide they like REITs because of the predictability of dividends — versus an industrial company, where dividends might not be as predictable — I think they’re still going to gravitate toward REIT stocks.”

Meanwhile, despite talk last year of ending the tax break on primary-home sales, profits of up to $500,000 (depending on marital status) from those sales remain tax-free.

Plus, for commercial owners, the 15-year write-off for physical improvements on properties was extended for properties coming online through 2013 and made retroactive to include 2012 improvements as well.

Ultimately, the implications of the fiscal cliff deal pale in comparison to previous major tax changes, especially those in 1986, experts said.

“I don’t see a major shift in behavior or a sentiment shift away from the real estate asset class because individual investors are paying marginally higher taxes,” Roschelle said.

“I don’t mean to trivialize 5 percent,” he added, “but I don’t think it’s a big enough tax reform to change behavior.”